6-K 1 santander-6k_83112.htm Unassociated Document


FORM 6-K

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Report of Foreign Issuer

Pursuant to Rule 13a-16 or 15d-16 of

Securities Exchange Act of 1934

For the month of Septermber 2012

SANTANDER UK PLC
(Translation of registrant's name into English)

2 Triton Square, Regent’s
Place, London NW1 3AN, England
(Address of principal executive offices)

    Indicate by check mark whether the registrant files or will file annual reports under cover Form 20-F or Form 40-F.

Form 20-F  x      Form 40-F  o

    Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.

Yes  o  No  x
 
 
 
 


 
 
Santander UK plc
2012 Half Yearly Financial Report

Business Review and Forward-looking Statements

Forward looking Statements

Santander UK plc (the ‘Company’) and its subsidiaries (together ‘Santander UK’ or the ‘Group’) may from time to time make written or oral forward-looking statements. Examples of such forward-looking statements include, but are not limited to:
 
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projections or expectations of revenues, costs, profit (or loss), earnings (or loss) per share, dividends, capital structure or other financial items or ratios;
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statements of plans, objectives or goals of Santander UK or its management, including those related to products or services;
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statements of future economic performance; and
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statements of assumptions underlying such statements.

Words such as ‘believes’, ‘anticipates’, ‘expects’, ‘intends’, ‘aims’, ‘plans’, ‘targets’ and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements.
 
By their very nature, forward-looking statements are not statements of historical or current facts; they cannot be objectively verified, are speculative and involve inherent risks and uncertainties, both general and specific, and risks exist that the predictions, forecasts, projections and other forward-looking statements will not be achieved.  Santander UK cautions readers that a number of important factors could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements made by Santander UK or on Santander UK’s behalf. Some of these factors, which could affect the Group’s business, financial condition and/or results of operations, are considered in detail in the Risk Management Report on page 52 and the Risk Factors section on page 186 and they include:

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the effects of UK economic conditions (e.g. housing market correction, rising unemployment, increased taxation and reduced consumer and public spending) and particularly the UK real estate market;
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the effects of conditions in global financial markets (e.g. increased market volatility and disruption, reduced credit availability and increased commercial and consumer loan delinquencies);
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the effects of the ongoing economic and sovereign debt crisis in the eurozone and any effects should any member state exit the euro;
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The credit quality of borrowers and the soundness of other financial institutions;
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the Group’s ability to access liquidity and funding on financial terms acceptable to it;
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the extent to which regulatory capital and liquidity requirements and any changes to these requirements may limit the Group’s operations;
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the effects of any changes to the credit rating assigned to the Group, any member of the Group or any of their respective debt securities;
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the effects of fluctuations in interest rates, currency exchange rates, basis spreads, bond and equity prices and other market factors;
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the extent to the Group may be required to record negative fair value adjustments for its financial assets due to changes in market conditions;
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the ability of the Group to manage any future growth effectively (e.g. efficiently managing the operations and employees of expanding businesses and maintaining or growing its existing customer base);
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the ability of the Group to realise the anticipated benefits of its business combinations and the exposure, if any, of the Group to any unknown liabilities or goodwill impairments relating to the acquired businesses;
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the effects of competition, or intensification of such competition, in the financial services markets in which the Group conducts business and the impact of customer perception of the Group’s customer service levels on existing or potential business;
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the extent which the Group may be exposed to operational losses (e.g. failed internal or external processes, people and systems);
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the ability of the Group to recruit, retain and develop appropriate senior management and skilled personnel;
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the effects of any changes to the reputation of the Group, any member of the Group or any affiliate operating under the Group’s brands;
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the effects of the financial services laws, regulations, administrative actions and policies and any changes thereto in each location or market in which the Group operates;
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the effects of taxation requirements and any changes thereto in each location in which the Group operates;
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the effects of the proposed reform and reorganisation of the structure of the UK Financial Services Authority and of the UK regulatory framework that applies to members of the Group;
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the effects of any new reforms to the UK mortgage lending market;
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the power of the UK Financial Services Authority (or any overseas regulator) to intervene in response to attempts by customers to seek redress from financial service institutions, including the Group, in case of industry-wide issues;
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the extent to which members of the Group may be responsible for contributing to compensation schemes in the UK in respect of banks and other authorised financial services firms that are unable to meet their obligations to customers;
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the effects which the UK Banking Act 2009 may have, should the HM Treasury, the Bank of England and/or the Financial Services Authority exercise their powers under this Act in the future against the Company;
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the Group’s dependency on its information technology systems;
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the risk of third parties using the Group as a conduit for illegal activities without the Group’s knowledge;
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the effects of any changes in the pension liabilities and obligations of the Group; and
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Santander UK’s success at managing the risks to which the Group is exposed, including the items above.
 
 
 

 
 
Undue reliance should not be placed on forward-looking statements when making decisions with respect to Santander UK and/or its securities. Investors and others should take into account the inherent risks and uncertainties of forward-looking statements and should carefully consider the foregoing non-exhaustive list of important factors. Forward-looking statements speak only as of the date on which they are made and are based on the knowledge, information available and views taken on the date on which they are made; such knowledge, information and views may change at any time. Santander UK does not undertake any obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.
 
Written forward-looking statements may appear in documents filed with the US Securities and Exchange Commission, including this Half Yearly Financial Report, reports to shareholders and other communications. The US Private Securities Litigation Reform Act of 1995 contains a safe harbour for forward-looking statements on which Santander UK relies in making such disclosures.

GENERAL INFORMATION
 
This announcement is not a form of statutory accounts. The information for the year ended 31 December 2011 does not constitute statutory accounts, as defined in section 434 of the Companies Act 2006. A copy of the statutory accounts for that year has been delivered to the Registrar of Companies. The auditor’s report on those accounts was unqualified, did not draw attention to any matters by way of emphasis and did not contain a statement under section 498(2) or (3) of the Companies Act 2006.
 
This report is also available on the Santander UK corporate website (www.aboutsantander.co.uk).

BRITISH BANKERS' ASSOCIATION CODE FOR FINANCIAL REPORTING DISCLOSURE
 
Santander UK voluntarily adopted the British Bankers’ Association Code on Financial Reporting Disclosure (the ‘BBA Code’) with effect from its 2010 Annual Report on Form 20-F. The BBA Code sets out five disclosure principles together with supporting guidance. These principles have been applied, as appropriate, in the context of the 2012 Half Yearly Financial Report.

CHIEF EXECUTIVE OFFICER’S REVIEW
OVERVIEW
 
In the first half of 2012 we continued to focus on the development of our UK retail and corporate banking services. We delivered a solid business performance, with profit before tax up 32% to £725m, from £549m in the first half of 2011; the first half results of 2011 included a £731m provision for customer remediation, principally in relation to payment protection insurance (‘PPI’). Our financial results continued to be impacted by low interest rates, increased term funding costs and higher liquidity costs. Despite these challenges, the uncertain prospects for economic growth and the evolving regulatory environment, Santander UK strengthened its balance sheet with an increase in its Core Tier 1 capital ratio to 12.2%.
 
Santander UK maintained its reputation for offering customers innovative new products with the launch of our market leading current account in March as part of the ‘1|2|3 World’ range which has been well received and seen a good take-up by new customers and existing current account holders. We also delivered an excellent performance in the cross-tax year ISA campaign and an increase in lending to small and medium-sized enterprises (‘SMEs’) which grew by 18%. Mortgage lending demand remained weak but we continued to support UK households with £8.7bn of gross mortgage lending, a level consistent with our mortgage stock market share. Improved levels of service satisfaction were achieved in our retail, corporate banking and intermediaries businesses.
 
The planned acquisition of certain Royal Bank of Scotland Group (‘RBS’) retail and corporate banking businesses, announced in 2010, is progressing, albeit at a slower pace than initially expected. The transaction will further accelerate the delivery of our strategic goals.

STRATEGIC FOCUS
 
Santander UK’s strategy is to transform its business into a market-leading retail and corporate bank. Underpinning each of the goals is our focus on making Santander UK the best for our customers, our people and our investors:

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Changing the focus of the retail bank to customers from products:
The 1|2|3 World product suite promotes deeper relationships with customers by rewarding them for holding multiple products and offering excellent value. We launched the 1|2|3 Current Account in March 2012 following the launch of the 1|2|3 Credit Card in the second half of 2011. We are changing the commercial model with the implementation of enhanced customer segmentation and allocation of customers to branches to build deeper and longer-term customer relationships. In the first half of 2012 we increased the proportion of sales of our main products made via the direct channels as we sought to do more business face-to-face.
 
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Growing the SME business, both organically and through acquisition:
We are now in our third year of consistent organic growth in lending to UK SMEs, with balances rising 18%, building on an extended product suite available to our customers and delivering profitable growth. The first investment has been made under our £200m Breakthrough programme, our fund to provide capital to support fast growth small companies. Organic growth combined with the potential offered by the planned acquisition of certain RBS corporate assets is expected to significantly increase the scale of our corporate business and improve the overall business mix of Santander UK.
 
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Continuing our focus on IT investment and efficiency:
Improvements in our customer service are beginning to emerge following significant investment in staff, processes and training. Investment programmes continue, related both to improvements in existing processes and capability and the planned RBS businesses acquisition.
 
In parallel with these commercial goals, our financial priority in 2012 has been to ensure that we further enhance Santander UK’s balance sheet strength, in terms of funding, credit quality and capital. This sound financial underpinning will provide the foundations for sustainable growth in the future as we continue to transform the business.

 
 

 

BUSINESS PERFORMANCE
 
With a distribution network across more than 1,300 branches and 33 regional Corporate Business Centres, Santander UK has a firm foundation on which to build a full-service commercial bank. Notwithstanding weaker demand in key markets, increased competitive pressures and a fragile economic outlook we achieved solid growth in lending to SMEs, a good level of mortgage lending and performed strongly in our 2012 cross-tax year ISA campaign. The launch of our new 1|2|3 Current Account in March 2012 and a joint marketing campaign with the 1|2|3 Credit Card produced good demand for both products, with customers responding well to the broad range of benefits these products offer.
 
We have taken actions in the first half of 2012 to manage the risks associated with higher loan-to-value and interest-only mortgages and to constrain balance sheet growth, whilst maintaining lending to key segments of UK individuals and businesses. Mortgage gross lending was £8.7bn in the six months ended 30 June 2012 equating to a gross lending market share of 13%, which was consistent with our stock market share of around 14%. SME lending balances were 18% higher than at the same time last year. Risk management and affordability measures are an important part of our lending decisions and our focus on low LTV and prime segments continues to feed through into relatively low levels of arrears in our mortgage portfolio and in Corporate Banking.
 
In the first six months of 2012 our retail customers opened 448,000 bank accounts and acquired 356,000 credit cards. In Retail Banking, we are seeking to develop and build deeper customer relationships through increased current account primacy and customer segmentation. The 1|2|3 World is a growing range of products which gives customers access to a broad range of benefits when the products are used on a day-to-day basis.

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The 1|2|3 Current Account pays cashback for a range of household bill paying transactions as well as attractive rates of interest on credit balances. This fee paying primary account is a core part of our customer driven retail banking proposition.
 
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The 1|2|3 Credit Card moves our proposition away from a balance transfer business model to further deepen relationships. Spend on 1|2|3 Credit Cards now exceeds that of the rest of our credit card portfolio.
 
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392,000 1|2|3 Current Accounts and 449,000 1|2|3 Credit Cards have been opened since their respective launches in March 2012 and September 2011, with a strong take up from both existing customers and switchers from other institutions. The combined marketing of 1|2|3 World products has been effective, with many customers benefiting from using both products.
 
Competition in the deposit market continued to be intense and, as a consequence, margins remained at very low levels. We continued to offer a mix of best-buy products and special offers targeted at new and existing customers and continued to reward our customers for doing more business with us. Retail deposit net inflows were £3.0bn over the period. This included a strong cross-tax year ISA campaign, with net inflows of ISAs amounting to £6.9bn. Flows were also supported by current account growth where total balances rose by £1.3bn. Offsetting these, we reduced short-term and rate-sensitive deposits that offered limited long term relationship opportunities. The cost of medium term funding (‘MTF’) issuance was high compared to historic levels, but given its duration and relative cost remained an attractive and important source of funding. In the first half of 2012, £11.8bn of medium term funding was raised across a mix of sources and geographies and at good rates, reflecting the market’s confidence in Santander UK.
 
Our SME balances were up 18% with £1.7bn of new facilities made available. The organic growth of Corporate Banking continued in the first half of 2012 during which five new regional Corporate Business Centres were opened to improve coverage and customer service, taking the number of centres to 33, with plans in place for more openings in the second half of the year. Our innovative Breakthrough programme, launched in 2011, continued to support fast growth small companies in their development. In business banking, we launched a new fee-paying account in the second half of 2011. In total, over 23,000 bank accounts were opened in the first half of 2012.
 
Our Markets business continued to perform well in the first six months of 2012 and, despite the volatile environment, profits increased compared to the same period last year. Investment in staff and technology enabled us to offer an expanded range of products in 2012, particularly in the Institutional and Foreign Exchange businesses where we continued to show growth in challenging markets.

IMPROVING CUSTOMER SERVICE
 
We remain committed to improving customer service within our businesses. The roll-out of a comprehensive behavioural change programme for our staff, designed to improve customer experience across our branch network, was completed in June 2012. We also finalised the recruitment of almost 200 additional telephony agents. This enabled us to launch an in-depth training and development initiative to further improve the service offered through this channel. Results from our internal monthly customer survey, Customer First, reflected the positive impact of our initiatives on customer satisfaction.

Our efforts are being recognised by the industry, as we have recently won awards from Moneywise for ‘Most Improved Service’, Your Money for ‘Best National Branch Network’ and Euromoney for ‘Best Bank in the UK’ for 2012. We were awarded the ‘UK Bank of the Year 2011’ by The Banker magazine for the third year running. We also received Moneyfacts 2012 awards for ‘Best Personal Finance Provider of the Year’ for the third consecutive year; ‘Best Current Account Provider’ for the new 1|2|3 Current Account and ‘Best Cash ISA Provider’; Card & Payments Trailblazer Awards 2012 ‘Best New Credit Card’; and Your Mortgage 2010-2011 ‘Best Direct Mortgage Lender’.

 
 

 
 
FUNDING, LIQUIDITY AND CAPITAL
 
Santander UK remained firmly focused on the UK with approximately 99% of its customer assets UK-related and approximately 85% of customer assets consisting of prime residential mortgages to UK customers. The non-UK element of our balance sheet related primarily to the United States. Our balance sheet has a minimal net exposure after collateral to eurozone peripheral countries, amounting to approximately 0.5% of total assets.
 
Customer assets were £0.5bn higher than at 30 June 2011. Increases in SME and corporate lending were partially offset by managed reductions in the retail mortgage and unsecured personal loan portfolios. Customer liabilities of £149.3bn increased relative to the year-end but were lower than at 30 June 2011, with outflows resulting from a management decision to switch funding away from rate-sensitive and shorter term deposits. This was offset by a successful ISA cross-tax year campaign, securing deposits with an attractive liquidity profile at relatively favourable margins in the first half of 2012. The loan-to-deposit ratio of 134% was 2 percentage points better than at 31 December 2011.
 
In the first half of 2012, £11.8bn of medium term funding was raised across a mix of sources and geographies, with only limited further issuance expected to be required in the second half. The cost of MTF issuance remains high compared to historic levels, but continues to be an attractive and important source of our diversified funding profile. We continued to be able to raise funds in wholesale markets even at times of great market uncertainty regarding the eurozone. Total liquid assets rose 23% in the half year to £69bn. This strengthened the conservative liquidity position of the balance sheet. Short-term funding balances have been actively reduced as part of the process of strengthening the balance sheet and reflecting our prudent liquidity profile.
 
The Core Tier 1 capital ratio increased to 12.2% at 30 June 2012. In July 2012, Santander UK launched an offer to buy back £1.9bn of certain debt capital instruments. The rate of take-up of this offer exceeded expectations and the scope of the offer was increased to meet demand.

KEY FINANCIAL HIGHLIGHTS
 
For the six months ended 30 June 2012, Santander UK’s profit before tax was £725m, 32% higher than the equivalent period in 2011 which included a provision of £731m for customer remediation, principally in relation to PPI.

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Income was down 16%, largely due to impacts associated with structural market conditions (low interest rates, increased MTF costs and higher liquidity costs). The most significant contributor was the impact of the sustained low interest rate environment given the run-off of structural hedges;
 
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Costs were well controlled with expenses up only 1% on the equivalent period in 2011 despite inflation and investments in Corporate Banking and in Retail Banking customer-facing staff. In March 2012 we announced the closure of 56 branches where there was overlap following the combination of Abbey, Alliance & Leicester and Bradford & Bingley branch networks;
 
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The cost-to-income ratio rose to 51%, from 42% in the first half of 2011, largely reflecting the fall in income;
 
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Total credit provisions were 42% higher than in the first half of 2011. This was significantly due to continued pressures in the legacy non-core corporate loan portfolio and older commercial real estate exposures written before 2009. Corporate lending written in the last three years is continuing to perform better than expected to date. Mortgage NPLs coverage remained at 20% in the first half of 2012, consistent with the position at the end of 2011.

THE ECONOMY AND UK REGULATION
 
The decline in economic activity (‘GDP’) in late 2011 continued into 2012, with GDP falling by 0.3% in the first quarter. The preliminary reading for the second quarter has shown a larger fall, of 0.5%, although the additional bank holiday in the quarter and the wet weather are reported to have a played a role in this and make the underlying trend more difficult to ascertain. The output figures are somewhat at variance with the employment figures so far in 2012. Over the period when output is reported to have fallen, employment has risen and the unemployment rate reduced to 8.0% in the three months to June.
 
With falling activity and heightened economic uncertainty, especially with regard to the prospects for the eurozone, additional quantitative easing was announced by the Monetary Policy Committee. Whilst the economic environment remains very challenging, the process of reducing the high level of public sector borrowing is continuing and demand for credit has remained subdued, prompting new policy measures. In the housing market, the number of loans approved for house purchase for the first half of 2012 was over 9% ahead of a year earlier, but part of this was due to the timing of the ending of the stamp duty relief for first-time buyers. In contrast, the mortgage market saw weaker remortgage activity in the first half of 2012, down 9% compared to a year ago. Overall, the level of housing market activity remains low relative to the experience of the previous decade.
 
The UK Government’s recent announcements on regulatory reform, particularly the Independent Commission on Banking (‘ICB’), imply considerable change is likely to be ahead for the banking industry. We believe that Santander UK is well placed to respond to these challenges.

 
 

 
 
LOOKING AHEAD
 
We believe that the remainder of 2012 and 2013 are likely to be tough for the UK banking industry. Macro-economic prospects have deteriorated markedly in recent months, and show little sign of recovery in the short term. This has inevitably affected the outlook for our profitability. Increased regulatory burdens, continued low interest rates and higher funding costs are expected to impact our results further. We will seek to mitigate the effects of these challenges and continue to tightly control costs in the coming years. A priority for 2012 is to further enhance the strength of our balance sheet. To that end we will continue to focus on maintaining the high quality of our lending, improving further our capital base and tightly managing the liquidity and funding positions.
 
We will continue to invest in the commercial transformation of the UK business. Our strategy remains for Santander UK to be a full-service, diversified, customer-centred commercial banking franchise and to emerge as the best bank in the country for our customers, our people and our investors. The progress we have made in becoming a full-service commercial bank is due to the effort and commitment of all our staff and I would like to extend my thanks for their hard work.
 
Innovation will continue be important to Santander UK. The 1|2|3 World product suite is designed to build and reinforce a long-term primary account relationship with retail customers. Putting customers at the forefront of our business is a key part of our focus and we plan to further improve and deepen our customer relationships by providing a tailored proposition and a competitive product range. We have made significant investment in improving our service quality and have further initiatives planned for the second half of the year and hope to see further improvements to customer satisfaction as a result.
 
A seamless handover for the retail and corporate customers involved in the planned RBS transaction is a core deliverable for both Santander UK and RBS. This is, however, a large and exceptionally complex migration. This complexity and our concern to ensure that the transfer happens smoothly for customers means that some aspects of the programme are taking longer than originally anticipated. Whilst final dates are not yet confirmed, we continue to work constructively with RBS on the detail of implementation, which will require FSA approval prior to formal implementation and completion.
 
Santander UK welcomes and will support recent initiatives announced by the UK Government and Bank of England to improve the flow of liquidity to UK banks to support lending to consumers and businesses.
 
Santander UK will continue to build on its record of strong corporate governance in risk management and compliance and to foster a professional culture that upholds high standards of ethical behaviour and puts customers’ interests first.
 
 
Ana Botín
Chief Executive Officer

BUSINESS AND FINANCIAL REVIEW
BUSINESS OVERVIEW
 
This Business and Financial Review contains forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in such forward-looking statements. See “Forward-looking Statements” on page 2.

GENERAL
 
Santander UK plc (the ‘Company’) and its subsidiaries (together, ‘Santander UK’ or the ‘Group’) operate primarily in the UK, under UK law and regulation and are part of the Banco Santander, S.A. group (together with its subsidiaries, ‘Santander’).  Santander UK is a significant financial services provider in the UK.

The structural relationship of Santander UK with the Santander group - the ‘subsidiary model’
 
The Santander group operates a ‘subsidiary model’. This model involves autonomous units, such as Santander UK, operating in core markets with each unit being responsible for its own liquidity, funding and capital management on an ongoing basis. The subsidiary model means that Banco Santander, S.A. has no obligation to provide any liquidity, funding or capital assistance, although it enables Banco Santander, S.A. to selectively take advantage of opportunities.
 
Under the subsidiary model, Santander UK primarily generates funding and liquidity through UK retail and corporate deposits, as well as in the financial markets through its own debt programmes and facilities to support its business activities and liquidity requirements. It does this in reliance on the strength of its balance sheet and profitability and its own network of investors. It does not rely on a guarantee from Santander or any other member of the Santander group to generate this funding or liquidity. Santander UK does not raise funds to finance other members of the Santander group or guarantee the debts of other members of the Santander group (other than certain of its own subsidiaries).
 
Exposures to other Santander group members are established and managed on an arm’s length commercial basis. All intergroup transactions are monitored by the Board Risk Committee of Santander UK and transactions which are not in the ordinary course of business must be pre-approved by the Board. In addition, Santander UK is subject to UK Financial Services Authority (‘FSA’) limits on exposures to, and on liquidity generated from, other members of the Santander group.

 
 

 
 
Planned acquisition of RBS branches (‘Project Rainbow’)
 
On 4 August 2010, the Company announced its agreement to acquire (subject to certain conditions) certain bank branches and business banking centres and associated assets and liabilities from RBS for a premium of £350m to net assets at closing. The consideration will be paid in cash and is subject to certain closing adjustments. The planned acquisition will further accelerate the delivery of the Company’s strategic goals. A seamless transfer of the retail and corporate customers involved is a core deliverable of the transaction for both the Company and RBS. The Company has progressed extensive work on its systems and products in preparation for the transfer and integration and is satisfied with the progress it has made. This is, however, a large and exceptionally complex migration. This complexity and concern to ensure that the transfer happens smoothly for customers means that some aspects of the integration programme are taking longer than originally anticipated. Whilst final dates are not yet confirmed, the Company continues to work constructively with RBS on the detail of implementation, which will require FSA approval prior to formal implementation and completion.

BUSINESS REVIEW - SUMMARY
 
Santander UK plc (‘the Company’ and its subsidiaries, together the ‘Group’ or ‘Santander UK’) sets out below its Interim Management Report for the six months ended 30 June 2012.
 
The results discussed below are not necessarily indicative of Santander UK’s results in future periods. The following information contains certain forward-looking statements. See “Forward-looking Statements” on page 2. The following discussion is based on and should be read in conjunction with the Condensed Consolidated Interim Financial Statements elsewhere in this Half Yearly Financial Report.

INTRODUCTION
 
Santander UK has prepared this Business and Financial Review in a manner consistent with the way management views the business as a whole. As a result, we present the following key sections to the Business and Financial Review:

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Business Review - Summary - this contains an explanation of the basis of our results and any potential changes to that basis in the future; and a summarised consolidated income statement with commentary thereon by line item;
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Divisional Results - this contains a summary of the results, and commentary thereon, for each segment;
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Balance Sheet Business Review - this contains a description of our significant assets and liabilities and our strategy and reasons for entering into such transactions, including:
 
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Summarised consolidated balance sheet - together with commentary on key movements, as well as analyses of the principal assets and liabilities;
 
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Off-Balance Sheet disclosures - a summary of our off-balance sheet arrangements, their business purpose, and importance to us;
 
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Capital disclosures - an analysis of our capital needs and composition; and
 
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Liquidity disclosures - an analysis of our sources and uses of liquidity and cash flows.

Basis of results presentation
 
The information in this Business and Financial Review reflects the reporting structure in place at the reporting date in accordance with which the segmental information in Note 2 to the Condensed Consolidated Interim Financial Statements has been presented.
 
The Company’s board of directors (the ‘Board’) is the chief operating decision maker for the Group. The segment information below is presented on the basis used by the Board to evaluate performance and allocate resources. The Board reviews discrete financial information for each segment of the business which follows the Group’s normal accounting policies and principles, including measures of operating results, assets and liabilities.
 
In the first half of 2012, certain non-core portfolios were transferred to Corporate Centre (formerly known as Group Infrastructure) where this was felt to be more appropriate for the management of these assets and liabilities. The non-core portfolios transferred into Corporate Centre included certain Social Housing assets and commercial mortgage loans, previously managed within Corporate Banking. With respect to the former, even though there are no credit concerns the terms of these loans are unfavourable in the current funding environment. The latter are typically medium to long-term arrangements primarily written via agents or intermediaries. The Group’s intention is to hold these assets to maturity and as such the balances will gradually decrease over time. The corporate legacy portfolio in run-off (largely relating to assets acquired as part of the acquisition of Alliance & Leicester) was also transferred to Corporate Centre from Corporate Banking. Non-core customer deposits are financial intermediary/institutional deposits which are managed centrally for liquidity purposes, most of which were previously managed within Corporate Banking or Markets. In addition, the management of reorganisation, customer remediation, and other costs, and hedging and other variances has been transferred to Corporate Centre, principally from Retail Banking.
 
The prior period’s segmental analysis has been adjusted to reflect the fact that reportable segments have changed.

 
 

 
 
GROUP SUMMARY
 
SUMMARISED CONSOLIDATED INCOME STATEMENT AND SELECTED RATIOS

   
Six months ended
30 June 2012
£m
   
Six months ended
30 June 2011
£m
 
Net interest income
    1,559       1,981  
Non-interest income
    671       686  
Total operating income
    2,230       2,667  
Administrative expenses
    (1,010 )     (985 )
Depreciation, amortisation and impairment
    (120 )     (138 )
Total operating expenses excluding provisions and charges
    (1,130 )     (1,123 )
Impairment losses on loans and advances
    (368 )     (259 )
Provisions for other liabilities and charges
    (7 )     (736 )
Total operating provisions and charges
    (375 )     (995 )
Profit before tax
    725       549  
Taxation charge
    (175 )     (136 )
Profit for the period
    550       413  
 
   
30 June 2012
   
31 December 2011
 
Core Tier 1 capital ratio (%)
    12.2 %     11.4 %
Total capital ratio (%)
    21.7 %     20.6 %
Risk weighted assets
  £ 77,443m     £ 77,455m  

Six months ended 30 June 2012 compared to six months ended 30 June 2011
 
Profit before tax increased by £176m to £725m (2011: £549m), benefiting from the non-recurrence of the significant customer remediation provision, principally in relation to payment protection insurance ('PPI'), of £731m before tax made in the first half of 2011. Profit before tax continued to be adversely impacted by structural changes in the market including holding higher levels of liquid assets, higher funding costs and the low interest rate environment. By income statement line, the movements were:

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Net interest income decreased by £422m to £1,559m (2011: £1,981m). The key drivers of the decrease were sustained lower interest rates which reduced income earned on the structural hedge and the increased cost of term funding and retail deposits. In addition, interest on overdraft accounts was lower with interest charges replaced by daily fees, included within non-interest income.
 
These decreases were partly offset by the favourable impact in Retail Banking of improved lending margins as more customers reverted to standard variable rate mortgages in the current low interest rate environment, and improved margins on new business in both the mortgage and unsecured loan portfolios.
 
Within Corporate Banking, net interest income increased as a result of growth in customer loans, with much of this growth generated through our network of 33 regional Corporate Business Centres which serve our clients in the UK SME market (total SME lending balances increased by 18% compared to 30 June 2011). Interest margins on loans continued to improve as market pricing better reflected incremental higher funding and liquidity costs.
 
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Non interest income decreased by £15m to £671m (2011: £686m). In Retail Banking, the increase in fees driven by the replacement of overdraft net interest income with daily fees was more than offset by a decrease in monthly overdraft fees charged to customers, a change in the mix of fees charged, and a higher volume of fees waived.
 
Within Corporate Banking, non interest income increased reflecting volume growth in the core businesses, particularly SMEs, resulting in increases in income from treasury services, banking and cash transmission services, invoice discounting and asset finance.
 
In Markets, the increase was largely driven by relative improvements in the Fixed Income business (especially in the first quarter) where there was a lack of profitable business in the market in the prior year.
 
In Corporate Centre, the decrease in non interest income was principally due to increased repo costs relating to the management of the liquid asset buffer being reported in net trading and other income, lower operating lease income reflecting reduced non-core assets and some losses on mark-to-market volatility.

>
Administrative expenses increased by only £25m to £1,010m (2011: £985m), despite inflation and continued investment in the business including five newly-opened regional Corporate Business Centres.
 
>
Depreciation, amortisation and impairment costs decreased by £18m to £120m (2011: £138m). The decrease reflected lower software depreciation costs following the impairment of certain intangible assets in December 2011.
 
>
Impairment losses on loans and advances increased by £109m to £368m (2011: £259m). The increase was partly due to higher impairment losses in the non-core corporate portfolios in Corporate Centre primarily a result of increased stress in the legacy portfolios in run-off of shipping and structured finance, as well as other legacy commercial real estate exposures written before 2009, particularly within the care home and leisure industry sectors. The overall increase also reflected the increase in levels of non-performing mortgage loans in Retail Banking following changes in collections policy.  The underlying performance of the mortgage book remains broadly stable due to the continued low interest rate environment and the high quality of the book.
 
>
Provisions for other liabilities and charges decreased by £729m to £7m (2011: £736m). The decrease primarily reflected the non-recurrence of the significant charge for customer remediation, principally payment protection insurance, incurred in the six months ended 30 June 2011 as described in Note 25 to the Condensed Consolidated Interim Financial Statements.

 
 

 
 
Taxation
 
The tax on the Group’s profit before tax differs from the theoretical amount that would arise using the basic corporation tax rate of the Company as follows:

   
Six months ended
30 June 2012
£m
   
Six months ended
30 June 2011
£m
 
Profit before tax
    725       549  
Tax calculated at a tax rate of 24.5% (2011: 26.5%)
    178       145  
Non deductible preference dividends paid
    1       1  
Non deductible UK Bank Levy
    10        
Effect of non-taxable income, non-allowable impairment losses, provisions and other non-equalised items
    (17 )     (13 )
Effect of non-UK profits and losses
    (1 )     (1 )
Effect of change in tax rate on deferred tax provision
    8       10  
Adjustment to prior period provisions
    (4 )     (6 )
Tax expense
    175       136  
Effective tax rate
    24.1 %     24.8 %

Six months ended 30 June 2012 compared to six months ended 30 June 2011
 
The effective tax rate for the first six months of 2012, based on profit before tax was 24.1% (2011: 24.8%). The effective tax rate differed from the UK corporation tax rate of 24.5% (2011: 26.5%) principally because of the effect of non-equalised items, the reduction in deferred tax asset as a result of the change in the tax rate and the impact of the non-deductible UK Bank Levy.

CUSTOMER ASSETS AND LIABILITIES

   
30 June 2012
   
31 December 2011
   
30 June 2011
 
   
£bn
   
£bn
   
£bn
 
Customer assets:
                 
Retail Banking
    172.2       175.4       174.6  
Corporate Banking
    19.1       19.0       15.7  
Corporate Centre
    11.3       11.9       11.8  
      202.6       206.3       202.1  
- of which SME loans
    11.4       10.7       9.6  
                         
Customer liabilities:
                       
Retail Banking
    120.7       117.7       121.2  
Corporate Banking
    14.9       15.8       15.0  
Corporate Centre
    13.7       15.7       17.1  
      149.3       149.2       153.3  

LENDING AND DEPOSIT FLOWS

   
Six months ended
   
Six months ended
       
   
30 June 2012
   
30 June 2011
   
Change
 
   
£bn
   
£bn
   
£bn
 
Customer Net Lending
                 
Retail Banking
    (3.2 )     (0.9 )     (2.3 )
Corporate Banking
    0.1       1.0       (0.9 )
Corporate Centre
    (0.6 )     (0.1 )     (0.5 )
Total
    (3.7 )           (3.7 )
                         
Customer Net Deposit Flows
                       
Retail Banking
    3.0       (1.7 )     4.7  
Corporate Banking
    (0.9 )     1.1       (2.0 )
Corporate Centre
    (2.0 )     0.5       (2.5 )
Total
    0.1       (0.1 )     0.2  

Customer assets of £202.6bn decreased relative to the year-end but were higher than at 30 June 2011. Increases in SME and corporate lending were more than offset by managed reductions in the retail mortgage and unsecured personal loan portfolios.
 
Customer liabilities of £149.3bn increased relative to the year-end but were lower than at 30 June 2011, with outflows resulting from a management decision to switch funding away from rate-sensitive and shorter term deposits. This was offset by a successful cross tax year ISA campaign, securing deposits with an attractive liquidity profile at relatively favourable margins in the first half of 2012. The first six months of 2012 also benefited from £1.3bn increase in current account balances following the launch of the 1|2|3 account.

CAPITAL
 
Discussion and analysis of the Core Tier 1 capital ratio, the total capital ratio and risk-weighted assets is set out in the “Balance Sheet Business Review – Capital management and resources” on pages 40 to 44.

 
 

 
 
Business Review – Divisional Results
 
This section contains a summary of the results, and commentary thereon, by Income Statement line item for each segment.

PROFIT BEFORE TAX BY SEGMENT

30 June 2012
 
Retail
Banking
£m
   
Corporate Banking
£m
   
Markets
£m
   
Corporate Centre
£m
   
Total
£m
 
Net interest income/(expense)
    1,594       191       (3 )     (223 )     1,559  
Non-interest income
    330       199       137       5       671  
Total operating income/(expense)
    1,924       390       134       (218 )     2,230  
Administration expenses
    (796 )     (139 )     (54 )     (21 )     (1,010 )
Depreciation, amortisation and impairment
    (89 )     (8 )     (1 )     (22 )     (120 )
Total operating expenses excluding provisions and charges
    (885 )     (147 )     (55 )     (43 )     (1,130 )
Impairment losses on loans and advances
    (234 )     (61 )           (73 )     (368 )
Provisions for other liabilities and charges
    (4 )                 (3 )     (7 )
Total operating provisions and charges
    (238 )     (61 )           (76 )     (375 )
Profit/(loss) before tax
    801       182       79       (337 )     725  
 
30 June 2011
 
Retail
Banking
£m
   
Corporate Banking
£m
   
Markets
£m
   
Corporate Centre
£m
   
Total
£m
 
Net interest income/(expense)
    1,693       171       (2 )     119       1,981  
Non-interest income
    374       184       86       42       686  
Total operating income
    2,067       355       84       161       2,667  
Administration expenses
    (795 )     (119 )     (51 )     (20 )     (985 )
Depreciation, amortisation and impairment
    (103 )     (6 )     (1 )     (28 )     (138 )
Total operating expenses excluding provisions and charges
    (898 )     (125 )     (52 )     (48 )     (1,123 )
Impairment losses on loans and advances
    (172 )     (59 )           (28 )     (259 )
Provisions for other liabilities and charges
                      (736 )     (736 )
Total operating provisions and charges
    (172 )     (59 )           (764 )     (995 )
Profit/(loss) before tax
    997       171       32       (651 )     549  

RETAIL BANKING
 
Retail Banking offers a comprehensive range of banking products and related financial services (residential mortgages, savings and banking, and other personal financial services products) to customers throughout the UK. It serves customers through the Santander UK network of branches and ATMs, as well as through telephone, internet channels and intermediaries. It also includes the private banking business which offers private banking and other specialist banking services to our customers.

Summarised income statement
   
Six months ended
30 June 2012
£m
   
Six months ended
30 June 2011
£m
 
Net interest income
    1,594       1,693  
Non-interest income
    330       374  
Total operating income
    1,924       2,067  
Administration expenses
    (796 )     (795 )
Depreciation, amortisation and impairment
    (89 )     (103 )
Total operating expenses excluding provisions and charges
    (885 )     (898 )
Impairment losses on loans and advances
    (234 )     (172 )
Provisions for other liabilities and charges
    (4 )      
Total operating provisions and charges
    (238 )     (172 )
Profit before tax
    801       997  

Segment balances
 
   
30 June 2012
£bn
   
31 December 2011
£bn
 
Customer assets
    172.2       175.4  
Risk weighted assets
    39.3       40.1  
Customer deposits
    120.7       117.7  
Mortgage NPLs ratio(1)
    1.57 %     1.46 %
Mortgage coverage ratio(1)(2)
    20 %     20 %
(1) Accrued interest is excluded for purposes of these analyses.
(2) Mortgage impairment loss allowances as a percentage of mortgage NPLs.

 
 

 
 
Business volumes
 
   
30 June 2012
   
30 June 2011
   
Change
 
Mortgage gross lending (1)
  £ 8.7bn     £ 9.7bn     £ (1.0 )bn
Mortgage net lending (1)
  £ (2.8 )bn   £ (0.4 )bn   £ (2.4 )bn
UPL gross lending
  £ 0.6bn     £ 0.7bn     £ (0.1 )bn
Retail deposit flows
  £ 3.0bn     £ (1.7 )bn   £ 4.7bn  
Investment sales API
  £ 1.0bn     £ 1.5bn     £ (0.5 )bn
                         
Residential retail mortgage loans
  £ 163.2bn     £ 165.2bn     £ (2.0 )bn
Unsecured personal loans (‘UPLs’)
  £ 2.6bn     £ 3.1bn     £ (0.5 )bn
                         
Bank account openings (2) (000’s)
    448       409       39  
Credit card sales (3) (000’s)
    356       274       82  
                         
Market share (4)
                       
Mortgage gross lending
    12.9 %     15.2 %     (2.3 %)
Mortgage stock
    13.6 %     13.8 %     (0.2 %)
Bank account stock
    9.2 %     9.1 %     0.1 %
(1)
Includes Social Housing loans held within Corporate Centre, to align with CML reporting.
(2)
Bank account openings include personal, SME and private banking current accounts.
(3)
Credit card sales only include personal credit cards distributed through the branches.
(4)
Market share of mortgage gross lending and mortgage stock estimated by Santander UK for each half, having regard to individual lending data published by the Bank of England for the first five months of each half year. Historic data is adjusted to reflect actual data published for the period. Market share of bank account stock estimated by Santander UK for each half year, having regard to market research published by CACI.
 
Retail Banking profit before tax

Six months ended 30 June 2012 compared to six months ended 30 June 2011
Profit before tax decreased by £196m to £801m (2011: £997m). By income statement line, the movements were:

>
Net interest income decreased by £99m to £1,594m (2011: £1,693m). The key drivers of the decrease in net interest income were the higher cost of retail deposits, and the higher cost of new term funding applied to the business. In addition, interest on overdraft accounts was lower with interest charges replaced by daily fees, which are included within non-interest income. These decreases were partly offset by the favourable impact of improved lending margins as more customers reverted to standard variable rate mortgages in the current low interest rate environment, and improved margins on new business in both the mortgage and unsecured loan portfolios.
 
>
Non-interest income decreased by £44m to £330m (2011: £374m). The replacement of overdraft net interest income with daily fees as a result of the new pricing structure for current accounts resulted in higher fees, but these were more than offset by a decrease in monthly overdraft fees charged to customers, a change in the mix of fees charged, and a higher volume of fees waived.
 
>
Administration expenses were broadly flat at £796m (2011: £795m). Reduced costs driven by further efficiencies were largely offset by increased investment in new Retail Banking products.
 
>
Depreciation and amortisation expenses decreased by £14m to £89m (2011: £103m). The decrease reflected lower software depreciation costs following the impairment of certain intangible assets in December 2011.  
 
>
Impairment losses on loans and advances increased by £62m to £234m (2011: £172m), with most of the increase relating to mortgages and unsecured loans. The increase in mortgages was largely due to the increase in the level of non-performing mortgage loans following a change in collections policy. The underlying performance remains broadly stable due to the continued low interest rate environment and the high quality of the book. The increase in UPL provisions largely reflects the strengthening of reserve levels.
 
Secured coverage remained conservative at 20%, whilst the stock of properties in possession (‘PIP’) increased slightly to 999 cases from 965 at 31 December 2011 and 939 at 30 June 2011. This level of PIP represented only 0.06% of the portfolio and remained well below the industry average.
 
>
Provisions for other liabilities and charges increased by £4m to £4m (2011: £nil).
 
Retail Banking segment balances
>
Customer assets decreased by 2% to £172.2bn (2011: £175.4bn) due to management actions taken to tighten the lending criteria associated with higher loan-to-value and interest-only mortgages.  
 
>
Risk weighted assets decreased by 2% to £39.3bn (2011: £40.1bn), reflecting the reduction in the mortgage asset and the 9% reduction in unsecured personal loans.
 
>
Customer deposits increased by 3% to £120.7bn (2011: £117.7bn) (but were 0.4% lower than at 30 June 2011). The first six months of 2012 benefited from a strong cross tax year ISA campaign and £1.3bn of current account balance growth following the launch of the new 1|2|3 account.  During the 12 month period from 30 June 2011, the benefit of the strong cross tax year ISA campaign and current account balance growth was more than offset by a reduction in short-term and rate-sensitive deposits that offered limited long-term relationship opportunities.
 
>
The mortgage NPL ratio increased to 1.57% (December 2011: 1.46%). The underlying performance remained broadly stable, with the overall increase largely due to a change in NPL collections policy resulting in more cases being classified as NPL’s. In addition, a small portion of the increase in the ratio was driven by the asset reduction. The mortgage NPL ratio remained considerably below the UK industry average based on Council of Mortgage Lenders (‘CML’) published data.
 
>
The strong mortgage coverage ratio has been maintained at 20% (2011: 20%).
 
 
 

 
 
Retail Banking business volumes

Mortgage gross lending in the first half of 2012 was £8.7bn, equivalent to a market share of 12.9%, with £2.8bn negative net lending due to a managed reduction in the mortgage stock. The expectation for the second half is for a further managed reduction in the mortgage stock and a lower market share.
 
Total gross unsecured personal lending in the first half of 2012 decreased by 14% to £0.6bn due to lending continuing to focus on higher credit quality customers focusing on existing customers. The de-leveraging of the unsecured personal loans book resulted in a 15% reduction in the asset to £2.6bn.
 
Bank account openings were up 10%, primarily due to the new 1|2|3 Current Account launched in March 2012.
 
>
Credit card sales through the Santander brand of approximately 356,000 cards grew by 30% with a continued focus on existing customers, and benefiting from approximately 303,000 new 1|2|3 credit cards opened in the first half of 2012.
 
CORPORATE BANKING
 
Santander UK started to develop its corporate banking capability in 2006 and, with the acquisition of Alliance & Leicester plc, significantly increased this capacity from 2008. The investment in, and development of, these operations has been significant, with good progress being made ahead of the acquisition of certain customers from RBS.
 
Corporate Banking provides a range of banking services principally to UK companies, with a focus on services for SMEs, providing a broad range of banking products including loans, bank accounts, deposits, treasury services, invoice discounts, cash transmission and asset finance. Small businesses with a turnover of less than £250,000 are serviced through the Business Banking division, while a network of 33 regionally-based Corporate Business Centres offers services to businesses with a turnover of £250,000 to £150m. In addition, Corporate Banking includes specialist teams servicing Real Estate, Social Housing and UK infrastructure clients.
 
Within Corporate Banking, the Large Corporates business is responsible for larger multinational corporate clients, including related activities principally comprising foreign exchange, money market and credit activities. These related activities are structured into two main product areas: Foreign exchange and money markets, and Credit. Foreign exchange offers a range of foreign exchange products and money markets runs the securities lending/borrowing and repo businesses. Credit originates loan and bond transactions in primary markets as well as their intermediation in secondary markets.
 
Summarised income statement

   
Six months ended
30 June 2012
£m
   
Six months ended
30 June 2011
£m
 
Net interest income
    191       171  
Non-interest income
    199       184  
Total operating income
    390       355  
Administration expenses
    (139 )     (119 )
Depreciation, amortisation and impairment
    (8 )     (6 )
Total operating expenses excluding provisions and charges
    (147 )     (125 )
Impairment losses on loans and advances
    (61 )     (59 )
Total operating provisions and charges
    (61 )     (59 )
Profit before tax
    182       171  

Segment balances

   
30 June 2012
£bn
   
31 December 2011
£bn
 
Total customer assets
    19.1       19.0  
Corporate SMEs
    9.8       9.1  
Total SMEs(1)
    11.4       10.7  
Risk weighted assets
    20.4       20.1  
Customer deposits
    14.9       15.8  
(1) Total SMEs includes assets held within Corporate Centre
 
 
 

 
 
Corporate Banking profit before tax
 
Six months ended 30 June 2012 compared to six months ended 30 June 2011
Profit before tax increased by £11m to £182m (2011: £171m).  By income statement line, the movements were:

>
Net interest income increased by £20m to £191m (2011: £171m) as a result of growth in customer loans, with much of this growth generated through the network of 33 regional Corporate Business Centres which serve our clients in the UK SME market (SME lending balances increased by 8% compared to 31 December 2011 and by 24% compared to 30 June 2011). Interest margins on loans continued to improve as market pricing better reflected incremental higher funding and liquidity costs.
 
>
Non-interest income increased by £15m to £199m (2011: £184m). Volume growth in the SME business resulted in increases in income from treasury services, banking and cash transmission services, invoice discounting and asset finance.
 
>
Administration expenses increased by £20m to £139m (2011: £119m). The increase reflected the continued investment in the growth of the business. During the first six months of 2012 we opened five regional Corporate Business Centres and significantly increased our capacity to serve small and medium sized businesses by recruiting 175 customer-facing people into our business.
 
>
Depreciation and amortisation increased by £2m to £8m (2011: £6m) due to the continued investment in the IT systems to support growth in the business banking and Corporate business.
 
>
Impairment losses on loans and advances increased by £2m to £61m (2011: £59m), with the credit quality of business written in the last three years continuing to perform better than expected to date.

Corporate Banking segment balances
>
Total customer assets increased by 1% to £19.1bn (2011: £19.0bn) (22% higher than at 30 June 2011) driven by a strong performance via our 33 regional Corporate Business Centres and a broader product offering. We continued to build our growing SME franchise, with lending to this group totalling £9.8bn, an increase of 8% compared to 31 December 2011 (24% compared to 30 June 2011). This was largely offset by the early repayment of a significant large corporate loan in the first six months of 2012.
 
>
Risk weighted assets increased by 2% to £20.4bn (2011: £20.1bn) due to higher SME and specialised lending.
 
>
Customer deposits decreased by 6% to £14.9bn (2011: £15.8bn) as a result of outflows occurring in the second quarter of 2012 following ratings agency downgrades and continued eurozone economic uncertainty. Notwithstanding this, the deposit base proved to be resilient. The division continues to focus on maintaining strong relationships with its core clients, as this has served us well over the period.

MARKETS
 
Markets is a financial markets business focused on providing value added financial services to financial institutions, as well as to the rest of Santander UK’s business. It is structured into two main product areas: Fixed income and Equity. Fixed Income covers sales and trading activity for fixed income products. Equity covers equity derivatives, property derivatives and commodities. Equity derivatives activities include the manufacture of structured products sold to both the Group and other financial institutions who sell or distribute them on to their customers.
 
Summarised income statement

   
Six months ended
30 June 2012
£m
   
Six months ended
30 June 2011
£m
 
Net interest expense
    (3 )     (2 )
Non-interest income
    137       86  
Total operating income
    134       84  
Administration expenses
    (54 )     (51 )
Depreciation, amortisation and impairment
    (1 )     (1 )
Total operating expenses excluding provisions and charges
    (55 )     (52 )
Profit before tax
    79       32  

Segment balances

   
30 June 2012
£bn
   
31 December 2011
£bn
 
Total assets
    27.2       28.7  
Risk weighted assets
    6.8       5.8  

Markets profit before tax
 
Six months ended 30 June 2012 compared to six months ended 30 June 2011
Profit before tax increased by £47m to £79m (2011: £32m).  By income statement line, the movements were:

>
Net interest expense increased by £1m to £3m (2011: £2m) due to increased funding costs reflecting the higher cost of new wholesale medium-term funding.
 
>
Non-interest income increased by £51m to £137m (2011: £86m), largely driven by relative improvements in the Fixed Income business (especially in the first quarter) where there was a lack of profitable business in the market in the prior year.
 
 
 

 
 
>
Administration expenses increased by £3m to £54m (2011: £51m), reflecting continued investment in growth initiatives relating to new products, markets and customer segments.
 
>
Depreciation and amortisation was unchanged at £1m.

Markets segment balances

>
Total assets decreased by 5% to £27.2bn (2011: £28.7bn), primarily reflecting a decrease in fair values of interest rate derivatives as a result of upward shifts in yield curves. There was a corresponding decrease in derivatives liabilities.
 
>
Risk weighted assets increased by 17% to £6.8bn (2011: £5.8bn) due to higher levels of trading activity increasing the stressed VaR.
 

CORPORATE CENTRE
 
Corporate Centre (formerly known as Group Infrastructure) consists of Asset and Liability Management (‘ALM’), which is responsible for the Group’s capital, and certain non-core and legacy portfolios being run-down and/or managed for value. ALM is responsible for managing the Group’s structural balance sheet composition and strategic and tactical liquidity risk management. This includes short-term and medium-term funding, covered bond and securitisation programmes. ALM's responsibilities also include management of Santander UK’s banking products and structural exposure to interest rates.

Summarised income statement

   
Six months ended
30 June 2012
£m
   
Six months ended
30 June 2011
£m
 
Net interest (expense)/ income
    (223 )     119  
Non-interest income
    5       42  
Total operating (expense)/income
    (218 )     161  
Administration expenses
    (21 )     (20 )
Depreciation, amortisation and impairment
    (22 )     (28 )
Total operating expenses excluding provisions and charges
    (43 )     (48 )
Impairment losses on loans and advances
    (73 )     (28 )
Provisions for other liabilities and charges
    (3 )     (736 )
Total operating provisions and charges
    (76 )     (764 )
Loss before tax
    (337 )     (651 )

Segment balances

   
30 June 2012
£bn
   
31 December 2011
£bn
 
Customer assets
    11.3       11.9  
Risk weighted assets
    10.9       11.5  
Customer deposits
    13.7       15.7  

Corporate Centre loss before tax
 
Six months ended 30 June 2012 compared to six months ended 30 June 2011
Loss before tax decreased by £314m to £337m (2011: £651m).  By income statement line, the movements were:

>
Net interest (expense)/income decreased by £342m to £(223)m (2011: £119m). The key drivers of the decrease were sustained lower interest rates which reduced income earned on the net structural position and the increased cost of term funding. The latter was partially offset by the allocation of some of these impacts to business units in line with the ongoing customer repricing.
 
>
Non-interest income decreased by £37m to £5m (2011: £42m), principally due to increased repo costs relating to the management of the liquid asset buffer being reported in net trading and other income, lower operating lease income reflecting reduced non-core assets and some losses on mark-to-market volatility.
 
>
Administration expenses increased by £1m to £21m (2011: £20m).
 
>
Depreciation and amortisation decreased by £6m to £22m (2011: £28m), due to lower operating lease depreciation resulting from lower balances in the non-core portfolio in run-off following the continued de-leveraging process.
 
>
Impairment losses on loans and advances increased by £45m to £73m (2011: £28m) due to the non-core corporate portfolios primarily a result of increased stress in the legacy portfolios in run-off of shipping, structured finance and real estate, as well as other legacy commercial real estate exposures written before 2009, particularly within the care home and leisure industry sectors.
 
>
Provisions for other liabilities and charges decreased by £733m to £3m (2011: £736m). The decrease primarily reflected the non-recurrence of the significant charge for customer remediation, principally payment protection insurance, incurred in the six months ended 30 June 2011 as described in Note 25 to the Condensed Consolidated Interim Financial Statements.
 
 
 

 
 
Corporate Centre segment balances

>
Customer assets decreased by 5% to £11.3bn (2011: £11.9bn) due to the run-down of the non-core portfolios and changes in credit spreads on Social housing loans accounted for at fair value.
 
>
Risk-weighted assets decreased by 5% to £10.9bn (2011: £11.5bn) in line with the reduction in customer assets.
 
>
Customer deposits decreased by 13% to £13.7bn (2011: £15.7bn), as a result of outflows of institutional balances occurring in the second quarter of 2012 following ratings agency downgrades and continued eurozone economic uncertainty.
 
BALANCE SHEET BUSINESS REVIEW
 
Throughout this section, references to UK and non-UK, in the geographic analysis, refer to the location of the office where the transaction is recorded.

SUMMARY
 
This balance sheet business review describes the Group’s significant assets and liabilities and its strategy and reasons for entering into such transactions. The balance sheet business review is divided into the following sections:

 
Page
Summarised consolidated balance sheet
23
   
In the remaining sections of the Balance Sheet Business Review, the principal assets and liabilities are summarised by their nature, rather than by their classification in the balance sheet.
 
   
Reconciliation to classifications in the Consolidated Balance Sheet
26
   
Securities:
27
>
Analysis by type of issuer
27
   
Loans and advances to customers:
27
>
Impairment loss allowances on loans and advances to customers
27
     
Country risk exposure
28
>
Sovereign debt
30
>
Other country risk exposures
31
>
Peripheral eurozone countries
32
>
Balances with other Santander companies
33
>
Redenomination risk
36
   
Derivative assets and liabilities
37
   
Tangible fixed assets
37
   
Deposits by banks
37
   
Deposits by customers
38
 
 
 

 
 
Short-term borrowings
38
   
Debt securities in issue
39
   
Retirement benefit assets and obligations
39
   
Off-balance sheet arrangements
39
   
Capital management and resources
40
   
Funding and Liquidity
45
>
Sources of funding and liquidity
45
>
Encumbrance
46
>
Funding sources, including wholesale funding
46
>
Credit rating
47
>
Liquid assets
48
>
Uses of funding and liquidity
48
>
Cash flows
49
   
Interest rate sensitivity
50
   
Average balance sheet
51

SUMMARISED CONSOLIDATED BALANCE SHEET

   
30 June 2012
£m
   
31 December 2011
£m
 
Assets
           
Cash and balances at central banks
    30,067       25,980  
Trading assets
    32,833       21,891  
Derivative financial instruments
    30,549       30,780  
Financial assets designated at fair value
    4,221       5,005  
Loans and advances to banks
    2,496       4,487  
Loans and advances to customers
    198,323       201,069  
Available for sale securities
    4,851       46  
Loans and receivables securities
    1,399       1,771  
Macro hedge of interest rate risk
    1,215       1,221  
Property, plant and equipment
    1,544       1,596  
Retirement benefit assets
    411       241  
Tax, intangibles and other assets
    3,625       3,487  
Total assets
    311,534       297,574  
Liabilities
               
Deposits by banks
    15,249       11,626  
Deposits by customers
    149,340       148,342  
Derivative financial instruments
    28,639       29,180  
Trading liabilities
    28,235       25,745  
Financial liabilities designated at fair value
    4,977       6,837  
Debt securities in issue
    62,176       52,651  
Subordinated liabilities
    6,558       6,499  
Retirement benefit obligations
    36       216  
Tax, other liabilities and provisions
    2,963       3,812  
Total liabilities
    298,173       284,908  
Equity
               
Total shareholders’ equity
    13,361       12,666  
Total equity
    13,361       12,666  
Total liabilities and equity
    311,534       297,574  

A more detailed consolidated balance sheet is contained in the Condensed Consolidated Interim Financial Statements.
 
Assets
 
Cash and balances at central banks
Cash and balances held at central banks increased by 16% to £30,067m at 30 June 2012 (31 December 2011: £25,980m) due to increased holdings of liquid assets maintained with the Bank of England as part of the Group’s liquidity management activity.

 
 

 
 
Trading assets
Trading assets increased by 50% to £32,833m at 30 June 2012 (31 December 2011: £21,891m). The increase principally reflected the higher repurchase agreements activity during the period.

Derivative assets
Derivative assets decreased by 1% to £30,549m at 30 June 2012 (31 December 2011: £30,780m). The decrease was driven by a decrease in fair values of interest rate derivatives as a result of upward shifts in yield curves. There was a corresponding decrease in derivatives liabilities.

Financial assets designated at fair value through profit and loss
Financial assets designated at fair value through profit and loss decreased by 16% to £4,221m at 30 June 2012 (31 December 2011: £5,005m). The decrease was primarily attributable to the maturity of, and changes in credit spreads on loans to UK Social Housing associations. New loans are not designated at fair value.

Loans and advances to banks
Loans and advances to banks decreased by 44% to £2,496m at 30 June 2012 (31 December 2011: £4,487m). The decrease was due to lower reverse repurchase agreement activity with Banco Santander, S.A..

Loans and advances to customers
Loans and advances to customers decreased by 1% to £198,323m at 30 June 2012 (31 December 2011: £201,069m), primarily due to a managed reduction in the mortgage stock.

Available for sale securities
Available for sale securities increased substantially to £4,851m at 30 June 2012 (31 December 2011: £46m). The increase reflected the purchase of government securities for liquidity management purposes.

Loans and receivable securities
Loans and receivable securities decreased by 21% to £1,399m at 30 June 2012 (31 December 2011: £1,771m). The decrease principally reflected the continuing run-down of the Treasury Asset Portfolio.

Macro hedge of interest rate risk
The macro (or portfolio) hedge decreased by less than 1% to £1,215m at 30 June 2012 (31 December 2011: £1,221m). The decrease was mainly due to increases in interest rates.

Property, plant and equipment
Property, plant and equipment decreased by 3% to £1,544m at 30 June 2012 (31 December 2011: £1,596m). The decrease was principally due to the depreciation charge for the period, partially offset by property acquired during the period.

Retirement benefit assets
Retirement benefit assets increased by 71% to £411m at 30 June 2012 (31 December 2011: £241m). For the Group’s defined benefit pension schemes which had surpluses, the key drivers of the increase were Company contributions during the period together with an increase in the net discount rate which generated a reduction in the present value of scheme liabilities.

Tax, intangibles and other assets
Tax, intangibles and other assets increased by 4% to £3,625m at 30 June 2012 (31 December 2011: £3,487m). The increase was primarily driven by capitalisation of software development costs partially offset by a slight decrease in tax assets.

Liabilities

Deposits by banks
Deposits by banks increased by 31% to £15,249m at 30 June 2012 (31 December 2011: £11,626m). The increase was driven by the increase in medium-term repurchase agreements as part of the Group’s funding strategy.

Deposits by customers
Deposits by customers increased by 1% to £149,340m at 30 June 2012 (31 December 2011: £148,342m). The increase is a result of a strong cross tax year campaign with the major ISA, as well as the launch of the keystone 1|2|3 current account.

Derivatives
Derivative liabilities decreased by 2% to £28,639m at 30 June 2012 (31 December 2011: £29,180m). The decrease was driven by a decrease in the fair values of interest rate derivatives as a result of upward shifts in yield curves.

Trading liabilities
Trading liabilities increased by 10% to £28,235m at 30 June 2012 (31 December 2011: £25,745m. The increase was mainly attributable to higher repurchase agreements activity during the period.

Financial liabilities designated at fair value
Financial liabilities designated at fair value decreased by 27% to £4,977m at 30 June 2012 (31 December 2011: £6,837m). The decrease reflected the maturity of debt securities from the medium term note programme that had been designated at fair value. These were replaced by longer medium term funding via the issuance of debt from the securitisation and Covered Bond programmes that are recorded at amortised cost. This resulted in a corresponding increase in Debt Securities in Issue.
 
 
 

 
 
Debt securities in issue
Debt securities in issue increased by 18% to £62,176m at 30 June 2012 (31 December 2011: £52,651m). The increase reflected the Group’s strategy of increasing the level of medium-term funding principally through the issuance of debt in the Covered Bond programme. These increases were partially offset by significant decreases in short term funding in the US$20bn Commercial Paper Programme and in Certificates of Deposit in issue. In addition, there were further maturities of debt outstanding under the US $40bn Euro Medium Term Note programme.

Subordinated liabilities
Subordinated liabilities increased by 1% to £6,558m at 30 June 2012 (31 December 2011: £6,499m). The small increase was primarily attributable to foreign exchange movements.

Retirement benefit obligations
Retirement benefit obligations decreased by 83% to £36m at 30 June 2012 (31 December 2011: £216m). For the Group’s defined benefit pension schemes which had deficits, the key driver of the decrease in obligations was an increase in the net discount rate which generated a reduction in the present value of scheme liabilities.

Tax, other liabilities and provisions
Tax, other liabilities and provisions decreased by 22% to £2,963m at 30 June 2012 (31 December 2011: £3,812m). The decrease principally reflected the payment of the dividend held in other liabilities at 31 December 2011 and the higher balance of accruals at the year end than the current period end and utilisation of provisions during the period in respect of customer remediation.

Equity
Total shareholders equity increased by 5% to £13,361m at 30 June 2012 (31 December 2011: £12,666m). The increase was principally attributable to retained profits for the period of £550m and an actuarial gain on retirement benefit obligations.
 
RECONCILIATION TO CLASSIFICATIONS IN THE CONSOLIDATED BALANCE SHEET - IBID
 
The classifications of assets and liabilities in the Group’s consolidated balance sheet, including the note reference, and in the balance sheet business review may be reconciled as follows:

30 June 2012
       
Balance sheet business review section
             
Balance sheet line item and note
 
Note
   
Loans and advances
to banks
   
Loans and advances to customers
   
Securities
   
Derivatives
   
Tangible fixed
assets
   
Retirement benefit assets
   
Other
   
Balance
sheet total
 
          £m     £m     £m     £m     £m     £m     £m     £m  
Assets
                                                                     
Cash and balances at central banks
                                              30,067       30,067  
Trading assets
    7       8,027       18,380       6,426                               32,833  
Derivative financial instruments
    8                         30,549                         30,549  
Financial assets designated at fair value
    9             3,618       603                               4,221  
Loans and advances to banks
    10       2,496                                           2,496  
Loans and advances to customers
    11             198,323                                     198,323  
Available for sale securities
    15                   4,851                               4,851  
Loans and receivables securities
    16       396       1,003                                     1,399  
Macro hedge of interest rate risk
                                                1,215       1,215  
Property, plant and equipment
    18                               1,544                   1,544  
Retirement benefit assets
    26                                     411             411  
Tax, intangibles and other assets
                                                3,625       3,625  
Total assets
            10,919       221,324       11,880       30,549       1,544       411       34,907       311,534  
 
                   
Deposits by banks
   
Deposits by customers
   
Debt securities
in issue
   
Derivatives
   
Retirement benefit obligations
   
Other
   
Balance
sheet total
 
                    £m     £m     £m     £m     £m     £m     £m  
Liabilities
                                                                       
Deposits by banks
    20               15,249                                     15,249  
Deposits by customers
                          149,340                               149,340  
Derivative financial instruments
    8                                 28,639                   28,639  
Trading liabilities
    21               7,969       18,568       1,698                         28,235  
Financial liabilities designated at fair value
    22                           4,977                         4,977  
Debt securities in issue
    23                           62,176                         62,176  
Subordinated liabilities
    24                           6,558                         6,558  
Retirement benefit obligations
    26                                       36             36  
Tax, other liabilities and provisions
                                                  2,963       2,963  
Total liabilities
                    23,218       167,908       75,409       28,639       36       2,963       298,173  
 
 
 

 
 
31 December 2011
       
Balance sheet business review section
             
Balance sheet line item and note
 
Note
   
Loans and advances
to banks
   
Loans and advances to customers
   
Securities
   
Derivatives
   
Tangible fixed
assets
   
Retirement benefit assets
   
Other
   
Balance
sheet total
 
          £m     £m     £m     £m     £m     £m     £m     £m  
Assets
                                                                     
Cash and balances at central banks
                                              25,980       25,980  
Trading assets
    7       6,144       6,687       9,060                               21,891  
Derivative financial instruments
    8                         30,780                         30,780  
Financial assets designated at fair value
    9             4,376       629                               5,005  
Loans and advances to banks
    10       4,487                                           4,487  
Loans and advances to customers
    11             201,069                                     201,069  
Available for sale securities
    15                   46                               46  
Loans and receivables securities
    16       957       814                                     1,771  
Macro hedge of interest rate risk
                                                1,221       1,221  
Property, plant and equipment
    18                               1,596                   1,596  
Retirement benefit assets
    26                                     241             241  
Tax, intangibles and other assets
                                                3,487       3,487  
Total assets
            11,588       212,946       9,735       30,780       1,596       241       30,688       297,574  
 
                   
Deposits by banks
   
Deposits
by 
 customers
   
Debt securities
in issue
   
Derivatives
   
Retirement benefit obligations
   
Other
   
Balance
sheet total
 
                    £m     £m     £m     £m     £m     £m     £m  
Liabilities
                                                                       
Deposits by banks
    20               11,626                                     11,626  
Deposits by customers
                          148,342                               148,342  
Derivative financial instruments
    8                                 29,180                   29,180  
Trading liabilities
    21               14,508       10,482       755                         25,745  
Financial liabilities designated at fair value
    22                           6,837                         6,837  
Debt securities in issue
    23                           52,651                         52,651  
Subordinated liabilities
    24                           6,499                         6,499  
Retirement benefit obligations
    26                                       216             216  
Tax, other liabilities and provisions
                                                  3,812       3,812  
Total liabilities
                    26,134       158,824       66,742       29,180       216       3,812       284,908  
 
SECURITIES

The Group’s holdings of securities only represent a small proportion of its total assets. The Group holds securities principally in its trading portfolio. These securities primarily consist of Government and Government-guaranteed securities held for liquidity purposes.
 
Securities analysis by type of issuer
 
The following table sets out the book and market values of securities at 30 June 2012 and 31 December 2011. For further information, see the Notes to the Condensed Consolidated Interim Financial Statements.

   
30 June 2012
£m
   
31 December 2011
£m
 
Trading portfolio
           
Debt securities:
           
UK Government
    1,889       1,078  
US Treasury and other US Government agencies and corporations
    197       65  
Other OECD governments – Switzerland and Japan
    1,782       1,800  
Other issuers:
               
- Fixed and floating rate notes – Government guaranteed
    2,081       5,754  
- Fixed and floating rate notes
          14  
Ordinary shares and similar securities
    477       349  
      6,426       9,060  
Available for sale securities
               
Debt securities:
               
UK Government
    3,765        
Other OECD Governments – France
    918        
Other issuers – Other
    146        
Ordinary shares and similar securities
    22       46  
      4,851       46  
Financial assets designated at fair value through profit and loss
               
Debt securities:
               
Bank and building society certificates of deposit
           
Other issuers:
               
 - Mortgage-backed securities
    314       328  
 - Other asset-backed securities
    47       51  
 - Other securities
    242       250  
      603       629  
Total
    11,880       9,735  
 
LOANS AND ADVANCES TO CUSTOMERS
 
The Group provides lending facilities primarily to personal customers in the form of mortgages secured on residential properties and lending facilities to corporate customers. Purchase and resale agreements represent sale and repurchase activity with professional non-bank customers by the Markets, Short Term Markets business.

Impairment loss allowances on loans and advances to customers
 
Details of the Group’s impairment loss allowances policy are set out in Note 1 to the Consolidated Financial Statements in the Group’s 2011 Annual Report. An analysis of period-end impairment loss allowances on loans and advances to customers, movements in impairment loss allowances, and Group non-performing loans and advances are set out in the “Loans and Advances” section of the Risk Management Report on page 71 and Note 11 to the Condensed Consolidated Interim Financial Statements.
 
 
 

 
 
COUNTRY RISK EXPOSURE
 
The Group manages its country risk exposure under its global limits framework. Within this framework, the Group sets its individual risk appetite for each country, taking into account any factors that may influence the risk profile of each country, including political events, the macro-economic situation and the nature of the risk incurred. Exposures are actively managed if it is considered appropriate. Accordingly, and over recent years, the Group has intensified its monitoring of exposures to sovereigns and counterparties in eurozone countries, and has proceeded to selectively divest assets directly or indirectly affected by events in those countries. As a result, the Group has insignificant exposure to Greece (30 June 2012: £3m, 31 December 2011: £3m) and Cyprus (30 June 2012: £nil, 31 December 2011: £nil). Spanish exposure is subject to ongoing monitoring, with reductions in non-parent related risk. Parent-related risk is considered separately.
 
The country risk tables below show the Group’s exposures to central and local governments, government guaranteed counterparties, banks, other financial institutions, retail customers and corporate customers at 30 June 2012 and 31 December 2011. Total exposures consist of the total of balance sheet values and off-balance sheet values. Balance sheet values are calculated in accordance with IFRS (i.e. after the effect of netting agreements recognised in accordance with the requirements of IFRS, principally with respect to derivatives) except for credit provisions which have been added back. Off balance sheet values consist of undrawn facilities and letters of credit.
 
The country of exposure has been assigned based on the counterparty’s country of incorporation except where the Group is aware that a guarantee is in place, in which case the country of incorporation of the guarantor has been used. The exposures are presented by type of counterparty other than where the specific exposures have been guaranteed by a sovereign counterparty in which case they are presented within the “Government guaranteed” category.
 
Separate disclosure is presented individually for each country where the exposure exceeds £50m, and aggregated for exposures of less than £50m. The domicile of an exposure is based on the country location of the ultimate risk, wherever possible. Given the ongoing interest in eurozone economies, disclosures relating to those economies are presented first and highlighted separately.
 
The tables exclude credit risk exposures to other Santander group companies, which are presented separately on pages 33 to 36.

30 June 2012
 
Central and local governments
£bn
   
Government guaranteed
£bn
   
Banks (2)
£bn
   
Other financial institutions
£bn
   
Retail
£bn
   
Corporate
£bn
   
Total(1)
£bn
 
Eurozone:
                                         
Peripheral eurozone countries: